Putting a Price on Carbon

Australia’s lower house passed a national carbon tax on October 12. The tax, once approved by the senate, will place a AU$23 price on each ton of carbon dioxide emitted or for each ton of carbon contained in fuels. Currently, the price of fossil fuels ignores the social costs that result from burning a ton of coal or a barrel of oil. The societal threats posed by climate change – droughts, floods, rising sea levels, water and food shortages, and political unrest, to name a few – are not included in the price of fossil energy and all the goods and services (basically everything) that depends on them. Thus the social costs are “externalized”, an economics concept which is akin to a 15th century mapmaker claiming that “there be dragons here.” A carbon tax internalizes these costs with the result that producers and consumers will make choices that create far fewer negative consequences.

From 1 July 2012, Australia’s largest emitters of greenhouse gas emissions will have to pay a fixed price of $23 per tonne of pollution produced here. The price will rise to $25.40 per tonne in 2014/15. From 1 July 2015, an emissions trading scheme will be introduced where the government releases a fixed number of permits which major emitters will need to purchase through auctions. In the early stages, major industries will be given permits for free, but the assistance gets scaled back. The number of permits released by the government will be capped to enable Australia to cut its emissions by five per cent by 2020, based on 2000 levels.

A carbon tax is more efficient than a cap-and-trade program. A tax offers more flexibility than a predetermined cap on emissions, and avoids significant year-to-year price fluctuations. This makes it easier for polluting firms to adapt and change their actions. This CBO report from 2008 summarizes the advantages of a carbon tax.

A tax on emissions would be the most efficient incentive-based option for reducing emissions and could be relatively easy to implement. If it was coordinated among major emitting countries, it would help minimize the cost of achieving a global target for emissions by providing consistent incentives for reducing emissions around the world. If other major nations used cap-and-trade programs rather than taxes on emissions, a U.S. tax could still provide roughly comparable incentives for emission reductions if the tax rate each year was set to equal the expected price of allowances under those programs.

The flexibility in reducing emissions that a tax affords is important because the cost of cutting emissions by a given amount could vary from year to year depending on such factors as the weather, the level of economic activity, and the availability of low-carbon technologies. A tax would provide a steady, predictable price for emissions. An inflexible cap, however, could result in volatile allowance prices, making a cap-and-trade program more disruptive to the economy than a tax would be.

Critics claim that putting a price on carbon will serve as a regressive tax by disproportionately affecting the lower layers of the economic spectrum. Producers will pass along increased costs to consumers. Wealthy people will be able to afford more expensive energy, but poorer folks, already strapped for cash, will struggle to pay more for transportation and food. Then again, the wealthy drive and fly more often, and are likely to have a larger carbon footprint than the poor, therefore those who can afford a more luxurious lifestyle would provide most of revenue from a carbon tax. To ensure that a carbon tax is equitable or progressive it must be revenue-neutral, which means the revenues are returned to the public rather than retained by the government, with the returns taking the form of a rebate or dividend. The Carbon Tax Center provides a clear and concise explanation of such a policy:

A carbon tax should be revenue-neutral. Revenue-neutral means that little if any of the tax revenues raised by taxing carbon emissions would be retained by government. The vast majority of the revenues would be returned to the public, with, perhaps, a very small amount utilized to mitigate the otherwise negative impacts of carbon taxes on low-income energy users.

Two primary return approaches are being discussed. One would rebate the revenues directly through regular (e.g., monthly) equal “dividends” to all U.S. residents. In effect, every resident would receive equal, identical slices of the total revenue pie. Just such a program has operated in Alaska for three decades, providing residents with annual dividends from the state’s North Slope oil revenues.

In the other method, each dollar of carbon tax revenue would trigger a dollar’s worth of reduction in existing taxes such as the federal payroll tax or state sales taxes. As carbon-tax revenues are phased in (with the tax rates rising gradually but steadily, to allow a smooth transition), existing taxes will be phased out and, in some cases, eliminated. This “tax-shift” approach, while less direct than the dividend method, would also ensure that the carbon tax is revenue-neutral and could offer other benefits. For example, reducing payroll taxes could stimulate employment.

Like any tax, particularly those that affect the status quo, the biggest polluters and their PR people decry the carbon tax as a job destroyer. Putting a price on carbon, they claim, is another way of asking industry to move to countries with less stringent or no environmental protections. Even if this were true in the short-term, it ignores the simple fact that the transition to a post carbon economy is already underway – whether they like it or not. Yes, the world still relies on coal, oil, and gas to power cities, vehicles, and everything else, but the solar and wind industries account for a bigger share of global energy production every day. Renewable energy will soon be (if is isn’t already) equally or less expensive than fossil energy. The countries and companies that lead the clean energy and technology revolutions will thrive while those still clinging to the 19th century business model soon will realize that they have become obsolete.